5 ways to address living too long in retirement

KennTacchino

Kenn Tacchino is a professor of taxation and financial planning at Widener
University in Chester, Pa. Kenn is the editor of the Journal of Financial
Service Professionals. The Journal reaches over 16,000 practitioners, academics,
and policy makers in the financial services industry. Professor Tacchino is also
a frequent speaker at professional meetings for financial planners. He can be
reached at kbtacchino@widener.edu.

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There are a variety of issues that could derail your retirement plans and end up leaving you “a day long and a dollar short.” Chief among these is living longer than planned, and thus exhausting your savings.

Financial planners call this longevity risk. The problem facing us is that the planning horizon for retirement income is indefinite and unknowable, and yet we need to secure an adequate stream of income for this unpredictable length of time.

The retirement planning process starts with taking into consideration your family and personal health history to estimate how long you will need to make your resources last. To make an educated guess about how long you will live, see livingto100.com, a website that asks a variety of questions to discern what only God knows.

The problem with an educated guess about how long you need to make your money last is just that, it’s a guess. Some will focus on the average life expectancy for a 65 year old, which is about 18 years. But don’t even think about planning for the average life expectancy because 50% of the people will outlive it. You may feel it is OK to assume a short life expectancy, but you can’t leave yourself exposed like that. Not only because the world is filled with people who lived longer than expected (see Table One), but because the first rule of sound financial planning is to protect you against risks that could cause financial ruin.

Longevity risk is chief among those risks. And remember that married couples need to focus on the age at which they expect the second spouse to die, so even if husband can reasonably predict a shorter life span the couple must still think about the plight of the widow. So one easy solution would be to plan conservatively and assume you will live to, for example, age 100 or 110. This, however, is probably ill advised since planning on living to an exaggerated age will place an undue burden on your spending throughout retirement.

Probability of living to a specific age if you are currently 65:

Age

Male

Female

70

94%

95%

75

85%

88%

80

73%

79%

85

54%

64%

90

33%

34%

It seems we’re caught between a rock and a hard place. If we estimate too short a period, we will consume our resources prematurely. If we estimate too long a period, we may have to lower our standard of living unnecessarily. Don’t despair. There are several potential products and strategies that can serve to eliminate or mitigate longevity risk.

These include:

Delaying claiming of Social Security benefits

Partially annuitizing a portion of assets

Purchasing something called an Advanced Life Delayed Annuity

Setting aside a separate fund to be used either as a legacy or a hedge against longevity

Executing a reverse mortgage

The delayed Social Security claiming strategy

Social Security benefits can be claimed as early as age 62 and should be claimed no later than age 70. For anyone retiring today, claiming at 62 means receiving 75% of their primary insurance amount. Claiming at full retirement age (66 for current retirees) means receiving 100% of their primary insurance amount. Claiming at 70 means receiving 132% of their primary insurance amount.

The primary insurance amount is the benefit you can expect from Social Security if you claim Social Security benefits at your full retirement age. The amount will be different for everyone because it’s based on your earnings history. For example, Patty is scheduled to receive $1,800 a month at her full retirement age of 66. If Patty claims Social Security at age 62, she will receive $1,350 a month every month she is alive (75% x $1,800). If she claims Social Security at age 70, she will receive $2,376 (132% x $1,800). The difference of $1,026 a month ($2,376 minus $1,350) will be paid as long as she is alive and it represents a significant hedge against longevity risk.

Looking at it another way, delaying Social Security is in effect an annuity purchase date choice, and purchasing a larger annuity at an advanced age will lead to greater insurance protection against the risks associated with running out of money in the later years of retirement. Waiting to age 70 is analogous to maximizing the insurance protection that Social Security provides against living too long.

What is even better is that married couples who defer claiming Social Security may add extra longevity risk protection because Social Security allows the surviving spouse to receive the increases associated with a delayed claiming. For example, Arthur and Katie are married. Arthur worked all his life and would receive $2,200 a month at his full retirement age. Katie was a stay-at-home mom and never worked and will receive a spousal benefit equal to 50% of Arthur’s benefits while Arthur is alive, and when Arthur dies, an amount equal to the benefit he was receiving. If Arthur claims at 62, he will receive $1,650 a month. When he dies, Katie will also receive $1,650 a month. If Arthur waits until age 70 to claim, he will receive $2,904 a month. When he dies, Katie will also receive $2,904 a month. By delaying claiming Katie will have $1,254 ($2,940 - $1,650) more a month after Arthur’s death than if Arthur grabbed Social Security when it was first available.

This differential can be the difference between a widow suffering poverty in her old age or continuing to live with enhanced financial security over a long life.

An annuity and/or Advanced Life Delayed Annuity (ALDA)

Financial services companies provide a product that is a foolproof way not to run out of money no matter how long you live. An immediate annuity pays income for a lifetime and is an insurance solution to the insurance problem of living too long (just like life insurance is an insurance solution to dying prematurely).

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